Case Study About Corporate Finance

Cover Page TX TEXAS Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Revenue Revenue Units sold 12,000,000 COGS Price per unit $400 Overhead Annual price increase 2% Labor PP&E Depreciation (Plant) Factory square footage 3,000,000 Depreciation (Equipment) Price per square foot $125 Property Tax Equipment $300,000,000 Operating Income 0 0 0 0 0 0 0 0 0 0 Salvage value $1 Useful life (years) 15 State & Federal Taxes Land $0 Operating Income After Tax 0 0 0 0 0 0 0 0 0 0 Tax Property tax 0.0% Add Depreciation State tax 3% After Tax Operating Cash Flows 0 0 0 0 0 0 0 0 0 0 Federal tax 21% Effective tax rate 24% Land Labor Factory Employees 5,000 Equipment Cost per employee $90,000 Working Capital Reserved 0 0 0 0 0 0 0 0 0 0 Wage inflation 3% Working Capital Returned 0 Operations Salvage Value Overhead (% of sales) 10% Tax on Salvage Value COGS (% of sales) 60% Total After Tax Cash Flows 0 0 0 0 0 0 0 0 0 0 0 Working capital (% of next year's sales) 10% Cost of Capital Present Values D/E ratio 0.8 NPV Interest rate 3.0% IRR Return on equity 35% % Equity 55.56% SUMMARY: % Debt 44.44% State NPV IRR WACC 20.46% Texas Pennsylvania North Carolina CONCLUSION: Orange Computers should locate its factory in ????, because... PA PENNSYLVANIA Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Revenue Revenue Units sold 20,000,000 COGS Price per unit $400 Overhead Annual price increase 2% Labor PP&E Depreciation (Plant) Factory square footage 5,000,000 Depreciation (Equipment) Price per square foot $160 Property Tax Equipment $500,000,000 Operating Income 0 0 0 0 0 0 0 0 0 0 Salvage value $50,000,000 Useful life (years) 15 State & Federal Taxes Land $20,000,000 Operating Income After Tax 0 0 0 0 0 0 0 0 0 0 Tax Property tax 0.5% Add Depreciation State tax 3% After Tax Operating Cash Flows 0 0 0 0 0 0 0 0 0 0 Federal tax 21% Effective tax rate 24% Land Labor Factory Employees 8,000 Equipment Cost per employee $80,000 Working Capital Reserved 0 0 0 0 0 0 0 0 0 0 Wage inflation 4% Working Capital Returned 0 Operations Salvage Value Overhead (% of sales) 10% Tax on Salvage Value COGS (% of sales) 60% Total After Tax Cash Flows 0 0 0 0 0 0 0 0 0 0 0 Working capital (% of next year's sales) 10% Cost of Capital Present Values D/E ratio 0.8 NPV Interest rate 3.0% IRR Return on equity 35% % Equity 55.56% SUMMARY: % Debt 44.44% State NPV IRR WACC 20.46% Texas Pennsylvania North Carolina NC NORTH CAROLINA Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Revenue Revenue Units sold 20,000,000 COGS Price per unit $400 Overhead Annual price increase 2% Labor PP&E Depreciation (Plant) Factory square footage 5,000,000 Depreciation (Equipment) Price per square foot $160 Property Tax Equipment $500,000,000 Operating Income 0 0 0 0 0 0 0 0 0 0 Salvage value $50,000,000 Useful life (years) 15 State & Federal Taxes Land $0 Operating Income After Tax 0 0 0 0 0 0 0 0 0 0 Tax Property tax 1.0% Add Depreciation State tax 3% After Tax Operating Cash Flows 0 0 0 0 0 0 0 0 0 0 Federal tax 21% Effective tax rate 24% Land Labor Factory Employees 8,000 Equipment Cost per employee $80,000 Working Capital Reserved 0 0 0 0 0 0 0 0 0 0 Wage inflation 5% Working Capital Returned 0 Operations Salvage Value Overhead (% of sales) 10% Tax on Salvage Value COGS (% of sales) 60% Total After Tax Cash Flows 0 0 0 0 0 0 0 0 0 0 0 Working capital (% of next year's sales) 10% Cost of Capital Present Values D/E ratio 0.8 NPV Interest rate 3.0% IRR Return on equity 35% % Equity 55.56% SUMMARY: % Debt 44.44% State NPV IRR WACC 20.46% Texas Pennsylvania North Carolina QUANTIC PROJECTS Corporate Finance Case Study Orange Computers has transformed into one of the largest smartphone companies in the world. Based on recent changes to the federal tax code, building phones in the US has become more attractive. Orange wants to build a single factory in either Pennsylvania, Texas, or North Carolina. Each state is offering incentives to woo Orange. North Carolina and Pennsylvania have proposed building a new facility, while Texas is offering grants to help renovate a recently closed factory. Project Description Build a workbook to calculate the net present value and internal rate of return (rounded to two decimal places) for each location over ten years using the information provided. Determine where Orange should locate their factory and give a brief explanation of why. Below are the pieces of information necessary to calculate the net present value and internal rate of return: 1. The factories in North Carolina and Pennsylvania could produce and sell 20 million phones annually, while the Texas factory could produce and sell 12 million. 2. Orange can sell all the phones produced at an average of $400 per phone in 2019 . Orange forecasts that they can gradually raise the price of their phones by1 2% per year over the next 10 years. 3. A new factory would be 5 million square feet at a cost of $160/ft2 to build in North Carolina or Pennsylvania. After grants, Orange would only need to pay $125/ft2 to renovate the existing 3 million square foot factory in Texas. 4. North Carolina will lease publicly owned land for the factory to Orange tax free, but the local government won’t waive the 1% annual property tax which is calculated on the initial cost of the factory. The land in Pennsylvania will cost $20 million, and the local property tax is 0.5%, calculated based on the initial cost of the factory plus the cost of the land. Since there is an existing factory in Texas, there will be no cost in purchasing the land, and the state has agreed to pay the local property tax for 10 years. 5. Orange plans to spend $500 million on equipment for the new factories in Pennsylvania or North Carolina. Salvage value for the equipment after 10 years is expected to be 10% of the equipment’s purchase price. Texas is offering to help pay for the equipment which lowers the cost to $300 million, but it has added a 1 Assume upfront investments in land, factory, and equipment are made in 2018. 9/11/21 - 1 ©2021 Pedago, LLC. All rights reserved. QUANTIC PROJECTS caveat that forces Orange to sell the equipment to the state for $1 when Orange disposes of the equipment after 10 years. 6. Orange can depreciate 100% of the cost of equipment when it’s put into service for tax purposes. (Since salvage value will be taxed as a gain at the end of 102 years, do not subtract it from the equipment’s value for depreciation.) All other depreciation will be on a straight-line basis over 15 years. (Don’t forget that there is no depreciation on land.) 7. The federal income tax rate for Orange is 21%. In their pursuit of new manufacturing jobs, all three states have offered different incentive packages that result in a state income tax equivalent to 3% for the first 10 years. State income tax is not deductible on federal taxes, so the effective tax rate is 24%. 8. Orange plans on hiring 8,000 workers in North Carolina or Pennsylvania with a total annual expense of $80,000 per worker. The factory in Texas would require 5,000 workers at $90,000 per year. Wage inflation is forecasted to be 5% per year in North Carolina, 4% in Pennsylvania, and 3% in Texas over the life of the project. 9. For operational expenses, assume that fixed overhead will be 10% of annual sales and cost of goods sold (excluding labor) will be 60% of annual sales at each factory. Orange will also need to maintain a total of 10% of next year’s sales in working capital. In other words, this is the cash that Orange will have to reserve for this project. It cannot be used elsewhere in the company.3 10. Orange keeps a stable debt-to-equity ratio of 0.8 and will use the same mix of debt and equity to finance this project. The average interest rate on its debt is only 3%, but its required rate of return on equity is 35%. Note that interest expense is not included in operating income as the interest rate has already impacted the weighted average cost of capital (WACC). Including interest expense in the operating income will double-count the effect of interest on the project. Learning Outcomes When completed successfully, this project will enable you to: ● Use your knowledge of capital budgeting to project financial outcomes and choose how to allocate resources between competing projects. 3 The case template has been pre-populated with the required formulas to capture working capital movements from one year to another. Note that working capital is released at the end of the project life (10 years). 2 The U.S. passed the Tax Cuts and Jobs Act (TCJA) in 2017, which allows companies to depreciate 100% of the equipment cost in the same year that it is put into service. This is also called Bonus Depreciation. 9/11/21 - 1 ©2021 Pedago, LLC. All rights reserved. QUANTIC PROJECTS Assignment Requirements ● The main component of this case study is the workbook you create with the provided information to calculate your net present values and internal rates of return. Begin by making a copy of this template . (Note: after opening the link, click “make a copy” to begin working on your own copy of the template.) As you start editing the sheet, you’ll receive warnings about editing protected ranges; as long as you made a copy of the template, it’s OK to edit the sheet however you want. ● Once you’ve completed your sheet, complete the sentence in the “Conclusion” box (on the “PA” sheet) with the correct response, as well as a brief rationale for why you chose your answer. ● To submit this project, ensure that link sharing is turned on and email the link to your finalized sheet to projects@quantic.edu. Please note that if you’re working in a group, your feedback will be emailed back to your entire group. If you do not wish to reveal your email to the rest of your group, email us at projects@quantic.edu to let us know. Tips & Resources ● Make sure to go through our Capital Budgeting and Finance for Excel courses before starting this project—these will help you prepare your workbook. ● If you have any questions, be sure to reach out to projects@quantic.edu for help! Corporate Finance Case Study Rubric Scores 2 and above are considered passing. Students who receive a 1 or 0 will not receive credit for the assignment, and must revise and resubmit to receive a passing grade. Score Description 5 ● Clearly addresses the case study prompt.● Workbook is complete, accurate, and intelligible. ● All SIX of the three net present values and three internal rates of return are accurate. ● Student arrives at the correct conclusion and an accurate rationale is provided. 9/11/21 - 1 ©2021 Pedago, LLC. All rights reserved. QUANTIC PROJECTS 4 ● Clearly addresses the case study prompt.● Workbook is complete and intelligible, and contains no more than three minor errors. ● At least FOUR of the three net present values and three internal rates of return are accurate. ● Student arrives at the correct conclusion and an accurate rationale is provided. 3 ● Addresses the case study prompt.● Workbook contains all necessary information, but is disorganized and contains no more than six errors. ● At least THREE of the three net present values and three internal rates of return are accurate. ● Rationale is lacking, OR student arrives at the wrong conclusion. 2 ● Somewhat addresses the case study prompt.● Workbook is missing a few pieces of information or contains more than nine errors. ● At least TWO of the three net present values and three internal rates of return are accurate. ● Rationale is lacking AND student arrives at the wrong conclusion. 1 ● Barely addresses the case study prompt.● Workbook is missing many pieces of information and riddled with errors. ● Only ONE or NONE of the three net present values and three internal rates of return are accurate. ● Rationale is missing. 0 ● The assignment is plagiarized, not turned in, or completely off topic. 9/11/21 - 1 ©2021 Pedago, LLC. All rights reserved.